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Reserve Bank of India firm on scrapping pre-payment penalty

Posted Date : 08-Apr-2014 , 08:21:02 am | Posted By CASANSAAR print Print

The Reserve Bank is likely to order banks to scrap penalty on pre-payment of all retail and small corporate loans and do away with fines for failure to maintain minimum balance if the recent 'nudge' does not work, said a person familiar with the plan. 

RBI officials believe there is no justification for banks to charge pre-payment penalty on any loan since the entire system has moved to floating rates —be it deposits or loans — where rates are charged based on the prevailing markets, though with a lag of a few days or weeks. Last week, the central bank had advised lenders to stop levying such penalties. 

Furthermore, banks are seen to be discriminatory between retail and big corporate clients who often armtwist lenders to charge them lower because of their sheer size and have no penalty clause. In fact, when big corporates default, they restructure loans and pay lower interest rates and the tenor is extended. 

"All prepayments may be abolished," said a central banker who did not wish to be named. "When all loans are based on floating rates, where is the question of penalty? We may soon order them to do away with the practice." 

Citing costs, domestic banks charge between half and four percentage points of outstanding loans if customers attempt to pre-pay mortgage. This deters some customers who want to exit the debt burden early, and is a good revenue stream for some banks. It also helps bank tie customers down. Lenders argue that it creates uncertainty on asset-liability planning when competition lures existing customers with lower interest rates. "If the lender has the right to recall a loan, the borrower should also have the right to repay a floating rate loan where banks may not incur interest rate risk," said the RBI official. 

About a quarter of bank loans are retail loans while the share of small and medium enterprise loans is about 15%. During the monetary policy review last week, RBI governor Raghuram Rajan had advised banks to stop charging prepayment penalty on floating rate loans and non-maintenance of minimum balance. Banks, however, argue that there is a cost involved in offering services such as cheque books, ATM transactions and account statements, necessitating a minimum balance of Rs 20,000. 

"If you have consumer interest in mind, you will not push this," Aditya Puri, chief executive at HDFC BankBSE -0.06 %, said the day Rajan announced the move. "The alternative is then you charge for these services. If I start charging you for these services, you will actually end up paying more. This is only a suggestion. IBA will get back to them." 

Charges for non-maintenance of minimum balance vary between Rs 500 and Rs 2,000. This is not the first time banks and the sector regulator may be on a collision course. Three years ago, the RBI had directed banks not to charge any penalty on prepayment of home loans, after a similar nudge did not work. 

However, banks continue to charge pre-payment penalty on other floating rate loans products such as education, personal and car loans. 

"The philosophy of not charging prepayment penalty on floating home loan account should be mutatis mutandis applied to other floating retail loan," said AC Mahajan, chairman of Bank Codes and Standard Board of India. 

"If a customer is unable to maintain minimum account, banks should migrate such accounts to basic banking accounts, where they phase out value-added services," said Mahajan. (Economic Times)

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